JULY 2008 - The
growing popularity of socially responsible investment (SRI) is
closely related to the increasing awareness of environmental and
social issues and the advent of communication technologies that
allow wide, efficient circulation of new information and alternative
views.

From 1996
to 2007, SRI assets grew faster than the entire universe of managed
assets in the United States. SRI assets rose more than 324%, from
$639 billion in 1995 to $2.71 trillion in 2005, compared to 260%
($7 trillion to $25.1 trillion) over the same period for all managed
assets (Social Investment Forum Foundation, Investment Trends
Report, 2007). The same source also reports that socially
and environmentally responsible investing has grown at an average
annual rate of 26%. This ongoing growth indicates a shift in the
investment paradigm—not just in how investments are viewed,
but also in how portfolios are created and implemented.

Socially
Responsible Investing Defined

SRI may be
broadly defined as the act of committing money or capital to an
enterprise, the aims of which the investor wishes to foster with
the expectation of profit. When investors choose which investments
to undertake, they typically look for vehicles that have the potential
to generate good profits while minimizing risk. Although the investment
decision-making process varies for each investor, when investors
align their social or ethical criteria with their investments,
the term “socially responsible investing” becomes
an active investment philosophy. Thus, SRI is an emerging investment
trend aimed at doing more than just generating profits; it also
seeks to do well by doing good.

SRI covers
a range of investors, from individuals who donate to different
philanthropic causes, to the nonprofit organizations that, arguably,
perform the greatest amount of philanthropic work per capita because
it is central to their organizational goals. The ultimate success
of SRI going forward will depend upon how effectively it can align
the investment policies of private philanthropists and nonprofit
entities (such as foundations and endowments) with corporate investment,
policy, and production.

At present,
it can be argued that, after philanthropy, SRI accounts for the
next largest investment amount per capita because of its use of
metrics that are similar to those used by nonprofits as well as
business.

Evolution
of SRI

The SRI concept
began as a “values-based” approach to investing. This
initial approach aims at aligning investors’ beliefs and/or
values—to the greatest extent possible—with their
portfolio holdings. Values-based investors use their personal
values to help drive their portfolio construction, while paying
little attention to the financial impact of their decisions. Such
investors share the intent to act responsibly with their money.
They are primarily looking to achieve social objectives, while
also attempting to generate financial returns on their capital.

By the late
1990s, the “value-seeking” approach was developed
as an alternative SRI strategy. Value-seeking investors look to
see how social and environmental performance may drive a company’s
share value. Because these investors are more concerned with generating
profits, they look to nonfinancial “screens,” such
as environmental and social impacts, as factors that influence
stock performance. This approach represents the mainstream investor,
as well as institutional policy.

Investment
performance for SRIs is still measured by traditional benchmarks.
The Domini 400 Social Index (DS400) is an interesting SRI alternative
to the Standard & Poor’s 500 Index (S&P 500). The
DS400 is a float-adjusted market capitalization–weighted
common-stock market index created by Amy Domini and others at
KLD Research & Analytics, Inc., in 1990. It is modeled on
the S&P 500 and is intended to be a benchmark of large companies
considered socially responsible or ethical. The index consists
of 400 companies, weighted by market capitalization, selected
from the largest publicly traded companies in the United States
using KLD’s criteria. According to KLD, these criteria relate
to community relations, diversity, employee relations, human rights,
product quality and safety, environment, and corporate governance.
The DS400 has, since its inception, produced returns of 11.01%,
as compared to 10.57% for the S&P 500 (which tracks the performance
of 500 widely held, large-capitalization U.S. stocks) for the
period ending March 31, 2008. Although the performance of an index
is not indicative of the performance of any particular investment,
indexes are considered representative of their respective market
segments.

The final
approach to SRI, called “value-enhancing,” is used
by investors—mainly in pension funds—who generally
do not label themselves as “socially responsible.”
Value-enhancing investors aim to do exactly what that label implies:
increase the value of the companies in which they invest. Therefore,
such investors are known to use shareholder activism to force
companies to engage in good corporate governance. As fiduciaries,
these investors look to maximize the value of their holdings as
a way of catering explicitly to the expectations of their beneficiaries.
If the means to achieving that end overlap with some social good,
so much the better.

Regulation
and Disclosure: Sarbanes-Oxley Act

Two sections
of the Sarbanes-Oxley Act (SOX)—Title III, “Corporate
Responsibility,” and Title IV, “Enhanced Financial
Disclosures”—focus on a fundamental tenet of socially
responsible investors: corporate social responsibility.

Title III,
“Corporate Responsibility,” established a mandate
that senior executives take individual responsibility for the
accuracy and completeness of corporate financial reports. It defines
the interaction of external auditors and corporate audit committees
and specifies the responsibility of corporate officers for the
accuracy and validity of corporate financial reports.

Title IV,
“Enhanced Financial Disclosures,” describes enhanced
reporting requirements for certain financial transactions, including
off–balance sheet transactions, pro forma information, and
stock transactions of corporate officers. It requires the establishment
of internal controls for assuring the accuracy of financial reports
and disclosures, and mandates both audits and reports on those
controls. It also requires timely reporting of material changes
in the financial condition of corporate reports, as well as specialized
reviews by the SEC.

The procedures
mandated by SOX are similar, in practice, to what socially responsible
investors do: monitor numerous aspects of corporate governance,
including the disclosure of policies and procedures, board independence
and diversity, executive compensation, and the concerns of stakeholders
(people affected by or interested in an organization’s operations).

Socially
responsible investors seek to avoid companies that have demonstrated
poor governance structures or have experienced histories of illegal
or questionable activities such as securities fraud, insider loans,
or bribery and corruption. They wish to bypass companies whose
corporate governance and business practices compromise the interests
of shareholders, and they favor companies that publish sustainability
reports like those devised by the Global Reporting Initiative,
described below.

Regulating
and Disclosure: The Global Reporting Initiative

Incorporated
in Amsterdam in 2002 as an independent nonprofit, the Global Reporting
Initiative (GRI; www.globalreporting.org)
is an institution that has developed standardized sustainability
reporting guidelines through the active participation of worldwide
organizations representing the following stakeholders: business,
accounting, investments, the environment, human rights, research,
and labor.

GRI indicators
include measures of economic performance, such as community donation;
environmental performance, such as greenhouse-gas emissions and
water use; labor practices, such as employees’ health, safety,
and diversity; human rights, such as policies regarding child
labor and indigenous rights; community impact; bribery and political
contributions; and product responsibility, such as customer health
and safety, advertising, and consumer privacy.

The GRI produces
what has become the world’s de facto standard in sustainability
reporting guidelines, which organizations follow to publicly communicate
their economic, environmental, and social performance. GRI guidelines
are the most common framework used in the world for sustainability
reporting. At present, more than 1,000 organizations from 60 countries
use the guidelines to produce their sustainability reports. Organizations
that report a voluntary use of the GRI guidelines include corporations,
public agencies, smaller enterprises, nongovernmental organizations
(NGO), and industry groups.

Reporting
on sustainability performance is an important way for organizations
to manage their impact on sustainable development. Sustainable
development has many challenges, and it is widely accepted that
organizations have not only the responsibility, but also a great
ability to exert positive change on the world’s economy,
as well as on environmental and social conditions.

Reporting
leads to improved sustainable development outcomes because it
allows organizations to measure, track, and improve their performance
on specific issues. Organizations are much more likely to effectively
manage an issue that they can measure.

Because organizations
disclose information in the public domain, sustainability reporting
promotes transparency and accountability, in addition to helping
organizations manage their impact. Stakeholders can track an organization’s
performance on broad themes (e.g., environmental performance)
or on a particular issue (e.g., labor conditions in factories).
Performance can be monitored year over year, or it can be compared
to similar organizations.

As a result,
an increasing number of investors emphasize the significance of
environmental, social, and governance (ESG) issues, because these
issues carry the potential for material risk, including social
and environmental damage and legal liability. Consequently, socially
responsible investors are urging companies to issue sustainability
reports.

As ESG issues
move toward center stage, companies that currently provide sustainability
reports have an advantage over those that do not, from the standpoint
of the due diligence performed by socially responsible investors
and concerned portfolio managers. From the corporate standpoint,
sustainability reports could provide a competitive edge in attracting
and retaining a growing share of institutional and individual
investors. From the investor standpoint, sustainability reports
provide them with criteria beyond financial statements with which
to evaluate an investment. The ultimate mission of the GRI is
to make sustainability reporting by all organizations as routine
and comparable as financial reporting.

Alignment
with Corporate Policy

Within the
nonprofit world, the growing desire among donors to invest in
ways that reflect their personal values and social priorities
makes SRI a highly effective tool that provides enterprises with
a competitive advantage, if they choose to adopt socially responsible
policies as a marketing point.

Not all companies
emphasize environmental, social, and governmental issues, however,
or do so effectively. This creates a challenge beneath the surface
of portfolio performance numbers. The problem is inherent in the
types of stocks and other financial instruments that nonprofit
investment portfolios of all sizes may find themselves holding.
The paradox is troubling: A nonprofit entity doing good works
through its people, programs, and financial resources could inadvertently
find its hard work undone by investments in companies whose policies
run counter to SRI philosophy.

Socially
Responsible Investing as a Change Agent

Adequate
portfolio returns are essential for funding the missions of nonprofit
organizations and maintaining their endowments. But these organizations
face more options than the choice between not making money and
compromising their goals. They face logistical challenges as well:
Large foundations and endowments may hold hundreds of positions
and have trouble keeping track of them, while small organizations
lack the resources to do effective social screening of their investment
options.

The growing
awareness that the ways in which people save, spend, and invest
can considerably influence society has increased the popularity
of SRI. Accordingly, it also makes sense for individual and institutional
investors with strong social goals to seek to forestall the potential
disconnect between value and valuation. Such investors are tending
to turn to SRI with the goal of achieving roughly the same returns
as other investments, instead of using investment vehicles that
do not share socially responsible investors’ ethical commitments.
(See the Exhibit.)

No long-term
study has yet shown a cost to SRI on a risk-adjusted basis (Social
Investment Forum Foundation, Investment Trends Report,
2007). As the belief grows that investors bear responsibility
for the impact of their money in the world, value-based, value-seeking,
and value-enhancing investors may find that they can play a crucial
role in improving the quality of society by establishing environmental,
social, and governance criteria for the corporate world. If this
is true, then it seems obvious that in a market-based global economy,
corporations will ultimately find themselves with no profitable
choice but to adjust to the values-based preferences of both the
investment world that buys their securities and the consumer culture
that purchases their products.

Expanded
from the moral compass in which socially responsible investing
maintains deep roots, even now, SRI and ESG products and policies
make it possible for personal and institutional investors to commit
their money to achieving some degree of social good, without being
undercut by corporate actions or products. As SRI expands as an
investment philosophy, it may well be able to change the concept
of investing from more than simply seeking financial returns,
to creating a robust vehicle that seeks to produce both investment
and social-improvement returns.

Neil
Rubin, CIMA, is senior vice president—investments,
at Oppenheimer & Co. Inc., New York, N.Y. He can be reached
at neil.rubin@opco.com.

This
article is not and is under no circumstances to be construed as
an offer to sell or buy securities. The information set forth
herein has been derived from sources believed to be reliable but
is not guaranteed as to accuracy and does not purport to be a
complete analysis of the market segments discussed. Opinions expressed
herein are subject to change with notice. Additional information
is available upon request. Neither Oppenheimer & Co. Inc.,
nor any of its employees or affiliates, provides legal or tax
advice.

The
CPA Journal is broadly recognized as an outstanding, technical-refereed
publication aimed at public practitioners, management, educators,
and other accounting professionals. It is edited by CPAs for CPAs.
Our goal is to provide CPAs and other accounting professionals
with the information and news to enable them to be successful
accountants, managers, and executives in today's practice environments.